Turning a service business into a product or software company can be tempting. While a typical consulting company may trade at a modest multiple of EBITDA, a fast-growing software company with sticky subscribers could sell at a double-digit multiple of revenue.
The difference is hard to ignore.
The challenge is that, unlike a service business, a product company can be challenging to finance. This funding gap leads many aspiring product owners to consult to raise the money they need to transfer their knowledge into a product one day.
If you’re going to use a consulting business to finance the development of your product, make sure you invest heavily in an excellent intellectual property (IP) lawyer. Have them develop a service contract that spells out who owns the IP you use in your consulting. Once created, be willing to walk away from a consulting client who is unwilling to sign your agreement or wants to make material changes to it.
How Justin Adams Avoided the Biggest Mistake Most Consultants Make
In 2017 Adams cofounded Digitize.AI to help hospitals get paid. They used artificial intelligence to get medical treatments preapproved by insurance companies, ensuring their patients could pay their medical bills.
The business was hungry for cash, and Adams and his wife put everything their young family had into the idea. At one point, Adams was so short on money that when their clothes dryer broke, the Adams family started hanging their laundry because they couldn’t afford the repair.
To keep his dream alive, Adams offered to consult for the hospitals he was pitching. Despite being desperately short of cash, he didn’t skimp on an IP attorney, who developed a contract that spelled out that Digitize.AI owned any IP that came out of their work for clients.
Adams also had the discipline to walk away from prospective consulting clients unwilling to sign their boilerplate contract.
By 2019 things had started to turn around for Adams. Digitize had signed up their first few hospitals for their software, reducing their reliance on consulting revenue. Adams began to have partnership conversations with other software companies in the medical industry. He was pleasantly surprised to learn his young company might be worth 15–25 times revenue.
Adams decided to sell his company, but before the acquirer agreed to hand over the money, they insisted on verifying that Adams owned the IP behind his software.
If your strategy is to use consulting to finance the development of a product, make sure you invest with an IP lawyer to develop a standard consulting agreement. It could make a difference in whether you’re able to enjoy a life-changing exit one day.